What is the commodity market?

The commodity market is a market where commodities – raw materials or primary agricultural products – are traded, rather than manufactured goods.

The commodity market is similar to the equity market, but instead of trading in shares, investors buy and sell commodities.

There are two broad types of commodities: 1. Agricultural goods, such as sugar, cocoa, and wheat (soft commodities), and 2. Raw materials, such as gold, silver and oil (hard commodities).

Commodities MarketInvesting in commodities is generally riskier than equities, because raw materials and primary agricultural products need to be stored, insured, and are at the mercy of political instability in many parts of the world.

There are four narrower categories for trading commodities. They include:

Energy: including natural gas, gasoline (UK: petrol), heating oil, and crude oil.

Metals: including silver, gold, platinum, nickel, zinc, and copper.

Livestock and Meat: including feeder cattle, live cattle, poultry, eggs, pork bellies and lean hogs.

Agricultural foodstuffs: including sugar, cotton, coffee, cocoa, rice, wheat, corn and soybeans.

We see commodities all around us. The commodities market influences the price of a gallon of gas, the cost of a cup of coffee bought from Starbucks or made at home, and the cost of electricity flowing into our homes and offices. The commodities market matters to all of us – it has a major bearing on our day-to-day lives.

As far as investors are concerned, there are approximately fifty major commodity markets globally that facilitate investment trade in almost 100 primary commodities. The volume of purely financial transactions is increasingly outnumbering physical trades in which goods are delivered.

According to ft.com/lexicon, the commodity market is:

“A market where commodities (oil, metals, farm products etc) are bought and sold.”

Several ways to invest in the commodity market

The oldest way of investing in commodities is with futures contracts, which are secured by physical assets.

Investors can buy shares in companies whose businesses rely on commodities prices. It is also possible to purchase index funds, mutual funds, or exchange-traded funds (ETFs) that focus on commodities-related businesses.

Different segments of the commodity market

The commodities market exists in two main forms: 1. The OTC (over the counter) market, and 2. The exchange based market. As with trading in stocks, there is also the spot and derivatives segments.

The spot markets are essentially OTC markets, which are usually restricted just to those actively engaged in producing and delivering that commodity – farmers, processors, wholesalers, etc.

Most of the derivative trading occurs through exchange-based markets with standardized contracts, settlements, etc.

History of commodity markets

Historians say that commodity markets and commodity-based money in a crude early form have their origins in Sumer (modern day southern Iraq) between 4500 BC and 4000 BC. Sumerians used clay tokens sealed in a clay vessel to represent quantities of livestock. They specified details of time and date of delivery, resembling today’s futures contracts.

Commodity markets, as we know them today, have their roots in the trading of agricultural products in Europe.

While cattle, pigs, corn and wheat were extensively traded using standard instruments in the 1800s in Western Europe and North America, other basic foodstuffs, such as soybeans and coffee were only added relatively recently.

For a commodity market to emerge and establish itself, traders and investors need to agree on what types of products there are, as well as acceptable standards of quality.

Video – Commodities explained

In this MoneyWeek video, Tim Bennet tells us what commodity markets are, and how investors can trade in them.